Cornwall Stodart Tax Digest: November 2010

INTRODUCTION

The Full Federal Court recently delivered its judgment on the
appeal by the Taxation Commissioner regarding an objection decision
of the Administrative Appeals Tribunal (AAT),
concerning a subsidiary of the News Corporation media conglomerate
(Newscorp). The court upheld the AAT's objection
decision that the Taxation Commissioner was not entitled pursuant
to Part IVA (the catch-all anti avoidance provision) of the
Income Tax Assessment Act 1936 (1936 Act)
to cancel a tax benefit arising from a complex reorganisation of
Newscorp's affairs. The court affirmed that where the intentions of
a taxpayer for entering into a tax scheme could be independently
verified (the objective intention), those intentions could be
relied on for determining whether or not the taxpayer's dominant
purpose was to procure the relevant tax benefit. This may appear to
depart from the view expressed in various High Court decisions
including FCT v Spotless Services Ltd (1996) 186 CLR 404,
FCT v Consolidated Press Holdings Ltd (2001) 207 CLR 235
and FCT v Hart (2004) 217 CLR 216.

BACKGROUND

NewsAust (an Australian incorporated and publicly listed
company) was the holding company for Newscorp. Over the years it
acquired operations spread across a number of countries. Although
its principal exchange was the Australian Stock Exchange, its
shares were also traded on other exchanges located around the
world. As the company matured, senior management decided that
commercial considerations (regulatory burdens and various other
inefficiencies) necessitated a group reorganisation, including that
the New York Stock Exchange would become the holding company's home
exchange. Through 2004 and 2005 transactions were entered into,
effecting the reorganisation. However, a precondition of the
reorganisation was that it did not give rise to tax liabilities or
the risk of the imposition of tax in any jurisdiction.

The process was divided into two stages; the first comprised
NewsAust issuing one hundred redeemable ordinary shares to a new US
(Delaware incorporated) company (NewscorpUS). In turn NewscorpUS
acquired all the NewsAust shares via a share swap/rollover
arrangement by allotting one of its ordinary shares for every two
non-redeemable NewsAust shares on issue. Once the swap was
completed, NewsAust cancelled all the non-redeemable shares that
NewscorpUS had acquired. NewsAust then issued new shares (equal in
number to those shares which had been cancelled) to a new
Australian incorporated entity (Carholt) - a wholly owned
subsidiary of NewscorpUS. NewsAust thereby became a subsidiary of
Carholt, which in turn was a subsidiary of NewscorpUS.

NewsAust at this stage continued to hold the interests in
enterprises that operated the group's UK and US publishing
businesses. This arrangement was referred to as the 'sandwich
structure', whereby two Australian companies sat between the
holding company (NewscorpUS) and the US and UK operations. This
revised group structure did not eliminate all operating and
structural inefficiencies. To alleviate the problem, Carholt
declared itself the head company of a consolidated group (which
included NewsAust) for Australian income tax purposes. This
required that the cost base of the consolidated group's assets be
established pursuant to the consolidation rules. The reduced cost
base of the interest Carholt held in the UK and US operations
amounted to $38.67B.

Stage two was implemented, whereby the shares owned by NewsAust
in the US and UK operations were distributed as a return of capital
to Carholt. These entities then implemented an off-market share
buy-back, payment for which was satisfied in the form of a Note
equal to the consideration due. Under Division 16K of the 1936 Act,
the consideration would be divided as between capital and income,
the latter constituting a dividend. Under section 23AJ, a dividend
from an overseas portfolio company is not subject to tax. The total
value of the buy-back was $38.75B, ($34.68B representing capital
and $4.07B representing the non assessable dividend portion). Given
that the reduced cost base (asset reset values) on consolidation of
Carholt's interest in the UK and US operations was $38.67B, it made
a capital loss of $3.99B ($38.67B-$34.68B). Pursuant to section
768-G of the Income Tax Assessment Act 1997 (Active
Foreign Business Asset Percentage), this capital loss was reduced
to $1.479B. At issue was whether Part IVA allowed the Tax
Commissioner to cancel the capital loss (tax benefit) resulting
from the restructure transactions.

Critical Issues for NewsAust

A condition for undertaking the transaction in any particular
form (motive), as put in the words of the respondent, was that it
produced 'no tax, no tax risk' - in other words the restructure (or
any part of it) would take place only on the condition that it did
not incur, or create a risk of incurring, a material tax liability
for a group entity in any jurisdiction. Moving the holding
company's location and positioning the UK and US operations
directly under a US holding company only became feasible with the
introduction in 1999 of the script for script rollover relief
provisions. Thereafter the restructure began to receive serious
consideration by Newscorp. Between 2000 and when the transaction
was implemented in 2004, NewsAust executives obtained various
advices from their external tax advisors and also directly from
Australian and US tax authorities; NewsAust sought to confirm that
the transaction in its original form (and in a subsequently amended
form) met the condition of the no tax, no tax risk condition. The
tax authorities confirmed that it did not give rise to any tax
liabilities, but the Taxation Commissioner would not give an
opinion on whether Carholt's capital loss would be allowed.

The question of making a 'choice' between alternative forms of
the transaction - one producing a tax benefit and one not producing
a tax benefit - was not raised as a significant issue. Settling on
the transaction's final form occurred because the original
transaction created a tax liability in the UK. Another variation of
the transaction appeared to run exchange gain risks that in turn
might give rise to substantial capital gains or losses, depending
on the timing of its implementation.

AAT FINDINGS

For the purposes of determining whether section 177(F)(c)
permits the Tax Commissioner to cancel a tax benefit (the capital
loss of $1.4B derived by Carholt), the various conditions of the
associated provisions of Part IVA need to be satisfied. Namely,
that there is a scheme (section 177A(1)), that there was a tax
benefit resulting from the scheme or part of the scheme (section
177C(1)), and that it would be concluded, having
regard to eight objective factors specified, that the purpose (or
dominant purpose if more than one) was to obtain the tax benefit
(section177D).

Ultimately the issue for the AAT was the application of the
dominant purpose test contained in section 177D (the AAT held that
a scheme existed and that a tax benefit was derived by the
respondent). The dominant purpose test distilled into a
consideration of whether the 'no tax, no tax risk' condition was
the dominant purpose for the scheme's implementation, or whether
the dominant purpose was the obtaining of the capital loss. The AAT
decided that, having regard to the eight matters listed in section
177D(b) (which require examining evidence to objectively establish
the reasons for the scheme's implementation), it would be concluded
that Carholt did not enter into or carry out the scheme to enable
it to obtain a tax benefit in connection with the scheme.

FEDERAL COURT PROCEEDINGS

The Taxation Commissioner's grounds of appeal were that the AAT,
in having regard to the 'no tax, no tax risk' pre-condition of
Newscorp's executives, took into account the subjective purpose
(motive) of the parties. The court found that the AAT had addressed
two quite separate issues. The first (the 'significant matter') was
the objective intention of the taxpayer that the restructure should
not involve adverse tax consequences. Any such objective intention
must be established on the evidence. The second issue was the
taxpayer's subjective intention which, as the AAT correctly stated,
was irrelevant to the questions before it. The court concluded that
the Commissioner's submissions failed to distinguish between
objective and subjective intentions or purposes. The court also
concluded that intention must be objectively ascertained by a
consideration of the factors listed in section 177D(b) of the 1936
Act.

The court also found the AAT was not '[p]recluded from
recognising that the "no tax, no tax risk" condition to the
transaction proceeding at all - an objective fact - had objectively
demonstrable consequences for both the manner in which the scheme
was entered into and carried out and its form and substance. To
recognise these matters was to not to stray into the subjective
territory proscribed by the reasoning in Commissioner of
Taxation v Hart (2004) 217 CLR 216'.

It is submitted that two issues have been conflated. The no tax,
no tax risk issue should only be considered (if at all) once the
validity could be objectively established of the assertion that the
'purpose' of the transaction was to remedy shortcomings inherent in
the group's original operating structure, or as varied by the
second phase of the transaction. While it may be accepted that
moving the group holding company's home exchange was the dominant
commercial purpose of the first part of the transaction, it is by
no means clear what purpose was served by implementing the second
phase of the transaction. Yet the court accepted, as did the AAT,
that the entire transaction remedied various deleterious effects of
the group's structure, without making any real enquiry as to the
nature of those effects. Yet if the group structure inefficiencies,
as ameliorated by implementing the transaction, could be
objectively established, the no tax, no tax risk issue would seem
largely irrelevant. It merely explains the form the transaction
took but is otherwise of no real purpose. The fact that Newscorp
was a multi-national enterprise was seen as sufficient to confirm
to the AAT and the court that all parts of the transaction were
explicable due to some larger commercial 'dominant purpose'.

The no tax, no tax risk issue is simply a threshold to the
question of whether the transaction should proceed and is not the
dominant purpose for entering into the transaction. Seen in that
context, each aspect of the transaction must be evaluated against
the underlying dominant purpose; ie the restructure transaction was
to effect material commercial improvement in the group's operations
or part of the group's operations.

Objective Purpose

In relation to whether it is permissible to have regard to the
objectively demonstrable intentions of a taxpayer, it has been
noted that '[t]he fact that a taxpayer may not have an actual
purpose of tax avoidance will not itself prevent the application of
Part IVA. The fact that a taxpayer's purpose can be established
[objectively]…does not answer the question posed by
section177D'.[1]

Gummow and Hayne JJ in Federal Commissioner of Taxation v
Hart[2] (Hart's Case) stated that '[t]hey
[the reasons explaining why the taxpayers acted as they did] are
not statements which provide an answer to the question posed by
s177D(b). That provision requires the drawing of a conclusion about
the purpose from the eight identified objective matters; it does
not require, or even permit, any inquiry into the subjective
motive of the relevant taxpayers or others who entered into or
carried out the scheme or any part of it' (italics added).

At first glance this may appear consistent with the view
expressed in the Newscorp case; that is, if the purpose of the
taxpayer can be objectively demonstrated, then it is permissible to
have regard to such matters when applying section 177D(b). However,
the reference in Hart's Case to 'subjective motives' must be
considered in juxtaposition to the court's view that section
177D(b) provides the objective basis for arriving at a
determination of whether the scheme was entered into for the
purpose of obtaining a tax benefit. In other words, the motive or
purpose of a taxpayer will always be regarded as subjective, even
where it can be objectively established, and must be disregarded.
The section determines the taxpayer's intention. As G T Pagone
stated: '[t]he question is not whether a person did enter into the
scheme for the tax benefit [or for some other reason]….but whether
someone would conclude that the he did from the
matters required to be considered by the section. The conclusion is
something which is attributed or imputed to a participant by force
of the section rather than a factual precondition to the operation
of Part IVA...'[3] (Note: Section 177D(b) does not prohibit
consideration of the alternative courses of action that were open
to the taxpayer to pursue.) Contrary to the court's view of the
evidence independently establishing the taxpayer's objective
intention, the evidence must be weighed in the context of the
operation of the section to determine the taxpayer's objective
intention.

IMPLICATIONS OF DECISION

If the case is not appealed, it may represent a shift in the way
Part VIA is applied. The case makes it plain that the objective
intention of the taxpayer is a relevant consideration for the
purposes of section 177D(b). In this regard, the court will accord
weight to the advice of the taxpayer's external advisors as part of
the evidence for establishing the purpose for implementing a
transaction. Further, it will be highly advantageous if, wherever
possible, other parties connected with potentially controversial
transactions document the reasons for their participation, and if
called upon these may be used in support of demonstrating a
taxpayer's intention.